But What About The Bailout For The Shadow Banking System?

Bond king Bill Gross has bad news for those with big hopes for the bank bailout: It won't do much. Unless we also revive the securitization markets, hedge funds, and other components of the shadow banking system, our economy will still be starved for capital.

How much will bailing out the shadow banking system cost?

At least another $1 trillion, says Gross. And that's just for the securitization part.

Bill Gross: [S]ecuritization has for several years exceeded bank loans as a percentage of private credit market debt. In contrast to recent headlines, however, banks have been picking up their lending, but it has been the “shadow banks” that have faltered.

That makes sense.

While banks may have tightened their lending standards, fresh capital from the TARP has made it possible to make new loans. The shadow banks, however – hedge funds, investment banks, and structured financial conduits – have been forced to delever as government funds have been directed to more visible institutional lenders. Granted, Goldman Sachs and Morgan Stanley have been TARP recipients, but only under the conditions of downsizing and degearing on their way to becoming regular banks, which have cut their holdings of assets significantly in percentage and actual dollar terms.

It should not surprise, therefore, that with the exception of specifically directed government programs directed at commercial paper rates and 30-year mortgage yields, past policies have been unsuccessful. Banks have been recapitalized – yes – and banks have cautiously started to lend. But shadow banks are still delevering due to disappearing and unavailable fresh capital and, as they do, they continue to drag asset prices with them.

PIMCO’s Ramin Toloui has produced Chart 2 which correlates the contraction in household debt to the decline of the securitization market. He estimates that there is a one trillion dollar hole that needs to be filled by policymakers in this area alone.

And this, of course, brings to mind the real problem: Our massive debt mountain. The government can stuff cash into the pockets of every financing institution in the country, and that won't suddenly put overleveraged consumers in a position to start borrowing again.